Monday, February 23, 2009

Is Another Great Depression Inevitable For Japan?

Japan, being the world second largest economy was previously seen as the most stable one among G7 nations in the current turbulence. Economists based this statement upon its level of exposure to bad loans which is very minimal, benchmarked against US & Europe. But, I argue that the claim is baseless considering Japanese economy which is very globalise & therefore susceptible to any external forces. Yes, it may not have direct exposure to subprime loans, but don’t forget it is still connected to the world out there through trade relations

Earlier, economists predicted that Japan will probably see no growth this year, which many thought of being too optimistic. To me, I see it as a sign of another inevitable depression. By definition, its economy is already in a recession (after 2 successive quarters of negative economic growth). To be classified as depression, its output will have to contract by more than 10%. Given the current indicators in US & Europe at large, the global economy is unlikely to turn around, not until early 2010.

Please refer to the following slide presentation to get better understanding as my explanations are solely based on the diagrams in that slides (couldn't upload for you guys due to different file format)

Why depression is imminent?

(1) Real GDP is fast contracting indicating that there is a severe fall in output. Lack of demand, domestically & internationally are the major driver. On the broader scale, falling real GDP also shows falling income on per capita basis

(2) CPI shows that prices of goods & services are still increasing but at a slower pace. Probably in couple of months, the growth rate will be negative. By then, deflation will took hold Japan once again. While inflation is bad, deflation is probably worse. In the period of falling price, consumers will tend to delay the purchase of cars, houses, cameras & others goods as they anticipate that price will further fall. However, by doing so means that there will be nobody spending into the economy. Fall in consumption, will cause AD to shift leftward. Real GDP will further contract followed by lower price level. The cycle continues

(3) Negative changes means that prices of land & most notably property is falling. This resembles a fall in asset wealth, which may trigger a crisis in consumer confidence & therefore spending. However, it is worth to take note that the negative changes are getting smaller by 2007 which may indicate that prices of property had likely to reach its low & stabilise. Unfortunately, the economic crisis seems to trigger the property price deflation once again

(4) Both exports & imports are collapsing. Demand for Japanese goods especially electrical & electronic goods collapse. Fall in the demand for cars is even worse due to its nature of being luxury goods (having YED > 1). For instance, sales of Mitsubishi fell by 77%, Mazda dropped 72% & Nissan by 62%. Overall, on an annual basis between January 2008 to January 2009, exports fell by 46%. Although, yen had strengthened against major currencies like US dollar, import still fell due to falling confidence, falling overall income & falling industrial activity which lead to lower import of raw materials & capital goods

(5) Yen is strengthening against the greenback due to the unwinding of yen carry trade activities. This heightened the scale of fall in exports. Demand for Japanese goods already fell due to slower economy in US & Euro-land & is exacerbated by the strength of yen which means Japanese goods are more expensive now. I’m not particularly sure if Bank of Japan does intervene actively to stabilise the exchange rate. But one thing for sure, it’s not healthy for an export-oriented economy like Japan. Fall in exports will cause a fall in AD, which also leads to contraction of real GDP. Through the negative multiplier effect, Japanese economy will contract further & at the faster pace. That’s why we see recently there are so many Japanese people being jobless & endless number of companies is desperate of shedding surplus of workers

(6) Of all the macroeconomic variables, I argue that rising unemployment in Japan will be the ‘graviest’ (actually there is no such word) concern for policy makers. Increasing unemployment is often associated with lost of confidence, falling consumer spending & the paradox of thrift which largely explains for the price deflation in Japan. Also it leads to other problems like failures of policy. I have mentioned much earlier that if people lost their confidence, no matter what the government does will not yield any desirable effect. For instance, its 0% interest rate (2001-2006) fails to jumpstart spending. Quantitative easing didn’t work too. On the other hand, excessive public spending which leads to ballooning national debt of 194% yields effect, but by a minor fraction

On top of that, falling birth rate coupled with rising number of elderly people mean lower tax receipts in future which will surely put more pressure onto government finances e.g. increasing demand for healthcare. Interest on debt repayment will worsen the situation

Falling capacity utilisation in manufacturing sector means more spare capacity in the economy. Machineries & other capital goods will not be used to their maximum capacity

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